Core Changes Have Improved Market Efficiency: Study

The policy and infrastructural changes that have been made in the Indian equity and capital markets have led to a 50 per cent gain in market efficiency since mid-1993.

This was stated in a study carried out by the Indira Gandhi Institute of Development Research and published in India Development Report, 1997.

This has been achieved through a reduction in transaction costs -- the cost imposed at the broker interface (brokerage fees), at the market (the market impact cost), at clearing (counterparty risk) and at settlement (paperwork and fraud).

Most of the increase in efficiency can be attributed to three separate developments in India's secondary market. These are the introduction of the open electronic limit order book market, the nationwide integration of markets and the introduction of the National Securities Clearing Corporation which guarantees all trades on the NSE in June, 1994.

As a result of these, total transaction costs on India's equity market have gone down from 5 per cent of the value of transactions in mid-1993 to 2.5 per cent currently.

Brokerage and market impact cost have gone down from 3.75 per cent in mid-1993 to only 0.75 per cent currently. Also while counter party risk was present in mid-1993, now it is only in part. Settlement costs are, however, still high at 1.75 per cent.

The next round of reforms -- depositories, indexation and derivatives -- aims at reducing transaction costs further to 0.5 per cent most of which will be achieved through a reduction in paperwork cost and bad paper risk to a mere 0.1 per cent.

This compares favourably with transaction costs in all major stock markets globally. Investors on the New York Stock Exchange currently incur a transactions cost of 1.23 per cent, most of which is a result of high brokerage fees of the tune of 1.00 per cent.